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B. What If an Owner Wants to Retire or Stop Working?

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times an active owner (as opposed to a passive investor) who wants to retire or stop working for the

company also wishes to retain all or part of his ownership stake. In some situations this may be just what

the continuing owners want, since this allows them

to keep the retiring owner’s capital in the business

and means they don’t have to come up with money

for a buyout. But in other situations the remaining

owners may not like this arrangement, reasoning that

they don’t want a passive investor to reap the benefits of their continuing hard work.

One thing is sure, it’s hard to know how one

owner’s deciding to retire or quit will be viewed

in the future. A lot will probably depend on

whether the departing owner and the remaining

owners are on good personal terms. But just

because you can’t predict the future doesn’t mean

you shouldn’t prepare for it by providing options

in the buy-sell agreement.

On balance it’s usually best to provide that,

when an owner quits her active duties, whether

as an officer or employee, the company and the

continuing owners have the option to purchase

her interest—in other words, to force the retiring

owner to sell his interest.

If you doubt this, consider what might happen

if a departing owner stops working for your business under less-than-amicable circumstances and

is poised to make trouble for management. Even if

circumstances are initially friendly, tensions may

eventually arise between the active owners, who

may be working long hours to build up the company, and an inactive owner, who may still want

to have a say in things and retain her right to a

share of the profits.



development issues. As a result, Mark quits to

follow his own dreams.

In the absence of a buy-sell agreement, Mark

can—and does—refuse to sell his minority

interest to Andromache and Eddie, apparently

believing that even though they are not as

farsighted as he is, Scripts Are Us is likely to

enjoy a profitable future. Unfortunately, Mark

doesn’t go quietly into the night. Instead,

Mark’s continual kibitzing becomes a constant

annoyance to Andromache and Eddie, who

particularly resent his periodic demands to

inspect the company’s books. Finally, after

several nasty spats at shareholders’ meetings

over the reinvestment of profits, Mark brings a

lawsuit against Andromache and Eddie, claiming they breached their “fiduciary duty to him

as a minority shareholder.”

No question that Andromache, Eddie and Mark

would have been far better off if, at the time their

business was formed, they’d adopted a buy-sell

agreement covering the eventuality that one of

them might cease to be active in the business—

specifically, one that provided the company and

the continuing owners with an option to buy a

retiring owner’s interest.

Such a provision doesn’t obligate the company

or the continuing owners to purchase the departing owner’s interest, but it gives them the option

to decide what to do in the future. We include a

clause that provides for this in our buy-sell agreement. It’s called an “Option to Purchase” clause,

and it is shown in Excerpt 1, below.

Worksheet. If you are interested in giving



EXAMPLE: Andromache and Eddie leave their



management positions at a large software

company to form a small custom-programming

shop (Scripts Are Us). They convince a programmer, Mark, to work with them by offering

him a minority interest in the new company.

After two years, during which Scripts Are Us is

modestly successful, Mark and the majority

owners no longer see eye to eye on product



the company and the continuing owners

the option to buy a retiring owner’s interest,

check Option 1 on your worksheet now. (Section

III, Scenario 1.)

How much of an owner’s interest can be

bought? Our agreement allows the



company and continuing owners to buy any or all

of the retiring owner’s interest. For example, if the



PROVIDING THE RIGHT TO FORCE BUYOUTS



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Section III: Providing the Right to Force Buyouts

Scenario 1. When an Active Owner Retires or Quits the Company’s Employ

Option 1: Option of Company and Continuing Owners to Purchase a Retiring

Owner’s Interest

(a) When an owner voluntarily retires or quits the company’s employ, he or she is deemed to

have offered his or her ownership interest to the company and the continuing owners for

sale. The company and the continuing owners shall then have an option, but not an

obligation (unless otherwise stated in this agreement), to purchase all or part of the

ownership interest within the time and according to the procedure in Section IV,

Provision 1 of this agreement. The price to be paid, the manner of payments, and other

terms of the purchase shall be according to Sections VI and VII of this agreement. An

owner who stops working for the company is referred to as a “retiring owner” below.

Excerpt 1



company and continuing owners can afford to

buy only half of the retiring owner’s interest, they

can do so.

Not for silent investors. If your company is



owned by both inactive, “silent” investors

and actively participating owners, this buyout

option may not suit your needs. (If an investor

was not working in the first place, retirement

should not change his situation with regard to the

company.) Since most of our advice is tailored to

small businesses where the owners are active in

the business, we don’t deal in detail with the

special needs (or problems) of “silent” investors.

If you face this situation, be sure to have an attorney look over your agreement. We cover finding

expert help in Chapter 10.



2. Right of Departing Owner to

Force a Sale

Rather than having trouble forcing a departing

owner to sell out, it’s far more likely that, when a

co-owner decides to leave a business, she’ll be

anxious to sell her interest, either to an outsider



or back to the company or the continuing owners. If she has no luck finding an outsider to buy

her interest, she’ll probably approach the company and the continuing owners. Sometimes the

company or the continuing owners will be happy

to buy the departing owner out—perhaps the

company is now quite profitable and the remaining owners will be pleased to increase their

shares. Or, perhaps the departing owner is leaving precisely because she wasn’t getting along

with the other owners and they’re glad to see her

go, even if it means they have to pay her for her

share of the company. In these and other workable circumstances, an ownership buyout is normally a fairly straightforward situation. Once the

deal is done, it’s business as usual with one less

owner.

But it’s not always so simple. What if the remaining owners don’t want to, or can’t afford to,

buy a departing partner out? In this situation, the

question often becomes: Can the departing owner

force the continuing owners to purchase his share

of the business? As you’ve probably guessed, the

answer is: not unless there is an agreement requiring it. Before you adopt a buy-sell provision

that will deal with this situation, you and your co-



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BUY-SELL AGREEMENT HANDBOOK



owners should ask yourselves a simple question:

Do you want an owner (who, after all, could be

any of you) to be able to force the company and

the continuing owners to buy her interest if she

decides to leave?

Especially if you’re a minority owner, your

answer is likely to be yes. It can be hard enough

to sell a majority interest in a small business, but

it can be next to impossible to sell a minority

stake—or even a 50% share.

EXAMPLE: Luis and Marta are equal partners in



a successful burrito shop that caters to the

business lunch crowd. After a few years of

long hours and hard work, Marta decides she

wants to sell her interest to Luis and get a job

where she can work shorter hours and spend

more time with her kids. Luis, who feels personally abandoned, is reluctant to further

stretch his already tight finances and is worried

about competition from a new deli that is

about to open in the area. He shrugs and says

he’s not interested in buying Marta’s interest.

Since she and Luis didn’t sign a buy-sell agreement, Marta has to search for an outside buyer.

She hires a business broker and spends money

advertising, but finds out that no one wants to

buy only half of a burrito shop. Potential buyers want the whole enchilada or nothing. After

looking for a buyer for months, Marta finally

ends up selling her share to Luis’s cousin for

far less than it was worth.

One way to deal with a problem like Marta’s is

to include a buy-sell provision that requires either

the company or its remaining owners to buy out

an owner who wants to leave. This type of

clause—we call it a “Right-to-Force-a-Sale”

clause—can protect a departing co-owner (who

may be leaving as the result of personal or financial distress) by guaranteeing a buyer for his ownership interest. The clause included in our buysell agreement that covers this option is shown in

Excerpt 2.



The effects of a required buyout on the company can be buffered by providing financial disincentives to leaving early, by requiring advance

notice of a departure and by using installment

plans, as discussed below.

Worksheet. If you are interested in giving a



retiring owner the power to force a sale of

her interest to the company and the continuing

owners, check Option 2 on your worksheet now.

(Section III, Scenario 1.) You can include both

Option 1 and Option 2 for retiring owners in your

agreement. It’s possible, and perfectly valid, to

include both Option 1—the option for the company and continuing owners to buy out a retiring

owner—and Option 2—a retiring owner’s right to

force a sale—in your agreement.

All or none of the interest can be offered.



Note that our Right-to-Force-a-Sale provision

does not allow a retiring owner to require the

company and the continuing owners to buy a

portion of her interest. A retiring owner can

request only that the company and continuing

owners buy all of her interest or none of it.

Not for silent investors. Generally, if your



company is owned by both inactive, “silent” investors and actively participating owners,

this clause will not suit your needs. (After all, if

an investor was not working in the first place, retirement should not allow him to force a buyout.)



a. Providing Disincentives to Leaving Early

No question, this type of forced buyout provision

allows all co-owners lots of leeway in deciding if

and when to leave the business. But personal

flexibility may not necessarily be a good thing for

your company or for the owners who are left

behind when one owner quits. Leaving aside the

fact that it may weaken all owners’ commitment

to their company, it creates the real possibility

that one or more owners will demand to be



PROVIDING THE RIGHT TO FORCE BUYOUTS



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Option 2: Right of Retiring Owner to Force a Sale

(a) When an owner voluntarily retires or quits the company’s employ, he or she can require

the company and the continuing owners to buy all, but not less than all, of his or her

ownership interest by delivering to the company at least 60 days before his or her

departure a notice of intention to force a sale (“Notice of Intent to Force a Sale”). The

notice shall include the date of departure, the name and address of the owner, a

description and amount of the owner’s interest in the company and a statement that the

owner wishes to force a sale due to the owner’s retirement as provided in this provision.

The procedure for purchase of the ownership interest shall be according to Section IV,

Provision 2 of this agreement. The price to be paid, the manner of payments and other

terms of the purchase shall be according to this section and Sections VI and VII of this

agreement. An owner who requests that his interest be purchased is referred to as a

“retiring owner” below.



Excerpt 2



cashed out precisely at a time when the company

is doing poorly or needs every bit of its cash for

another purpose, such as expansion.

Recognizing that a forced buyout may be

highly problematic, you may decide to head in

the opposite direction and say that a departing

owner can never force the company or other

owners to buy him out. But, of course, that brings

you right back to the worry you started with: the

possibility of getting stuck forever owning a share

of a business you no longer want, or selling your

share at a huge discount because you’re so

desperate to get out. This prospect is so unattractive—and potentially unfair—that it can lead to

horrendous results.

EXAMPLE: Dakon and Jed each contribute



$20,000 of their savings to open a climbinggear store in Colorado. To purchase inventory

and cover other start-up costs, they also take

out a bank loan. From the start they are

successful enough to pay the bills and eke out

small salaries, but not much else. Near the end

of the first year, Dakon tells Jed he wants out

of the business and would like his $20,000



back—running a business, it turns out, doesn’t

give him enough time to hit the peaks. Jed

can’t figure out a way to give Dakon his

investment back without selling off badly

needed inventory at fire sale prices (and

perhaps having to close the shop). Refusing to

do this, he tells Dakon that he can’t take his

money out of the business so soon and on

such short notice. This angers Dakon—after

all, he has worked hard at low pay for almost

a year! So one night Dakon grabs what he

guesses is $20,000 worth of climbing gear from

the store, loads it into his Jeep and takes off.

On the counter he leaves a note saying that

the store now belongs 100% to Jed. Left with

inadequate inventory, Jed can’t pay the store’s

debts and has to file for bankruptcy. Of

course, Jed may have a claim against Dakon,

but with Dakon off climbing mountains in

Chile, Jed is unlikely to collect anything.

Although it’s impossible to prevent a business

associate from acting as badly as Dakon did, you

can reduce the likelihood that this will occur. You

can do this by giving a departing owner a method



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BUY-SELL AGREEMENT HANDBOOK



for getting bck at least some of his investment—if

the company is operating in the black. At the

same time, you can avoid the other extreme of

allowing an owner to demand her money back at

any time. To accomplish this, your Right-to-Forcea-Sale clause can let an owner cash in her interest

only after a reasonable period of time. For instance, your clause can require the company to

buy out an owner only when he has been an active owner in the company three years or more.

Or, your agreement can provide that if an owner

leaves before the expiration of a required time

period, the company will be required to buy him

out, but only at a lowish price (say, 50% of the

business’s appraised value). This makes it clear to

the owners that, by going into business, they are

making a financial commitment to stick it out until the business becomes profitable—if they don’t,

they may lose all or part of their investment.

EXAMPLE: Let’s reroll our cameras and give Jed



and Dakon a legal framework designed to

cope with change. Knowing that Dakon is

highly susceptible to the call of the wild, early

on Jed raises the subject of what would

happen if one of them becomes unhappy with

the business and wants out. They jointly

decide that to get the business past its start-up

pains, each must make a minimum two-year

commitment. To enforce this point, they adopt

a buy-sell provision stating that if one of them

decides to leave during the first year, the other

will buy him out at a price that is 40% of the

standard buyout price set in the agreement. If

one of them leaves during year two, he gets

60% of the Agreement Price. Only if a co-owner

stays with the business into the third year is he

eligible to force a purchase for 100% of the full

Agreement Price.

The good news is that Dakon, realizing he

is committed, hangs in for almost three years,

at which point Jed has no trouble borrowing

the money to buy Dakon’s share for 100% of

the Agreement Price.



Choosing the required time period. The



length of time you require for a departing

owner to receive 100% of the Agreement Price

can vary with your type of business. For example,

if yours is the type of business likely to take five

or more years to fully establish, you may want to

pay a departing owner 100% of her interest’s

value only after this period is over.

There are, of course, times when an owner

really needs to leave and be cashed out, as

opposed to simply wanting to bail out to do

something else. For example, an owner with a

sick child may need to move closer to a particular

medical center, or an owner whose own health is

declining may be advised to quit working. In

situations like these, should the departing owner

be subject to the same discounts that would apply

to an owner who leaves his spouse and runs off

to the Cayman Islands? If your answer is no, you

can provide that an owner who leaves for a short

list of personal or family reasons is entitled to a

better deal than an owner who leaves on a whim.

EXAMPLE: Let’s rewind one more time. Dakon



and Jed are running their climbing-gear business with a solid buy-sell agreement in place

that outlines what will happen if one of them

leaves the business. Dakon learns that his

elderly mother has severe multiple sclerosis.

He decides he has to move back east to help

out his parents. Even though he and Jed have

only been in business less than a year, Dakon

points out that in case of a serious illness of a

co-owner’s spouse, child or parent, their

agreement provides that a departing owner is

entitled to 100% of the Agreement Price for his

interest.

The language included in our buy-sell agreement that gives you a choice of disincentive

options, one with a release clause in case of

injury or illness and one without, is shown in

Excerpt 3.



PROVIDING THE RIGHT TO FORCE BUYOUTS



3/11



(b) Disincentive option

Option 2a: Disincentive period, with illness/injury exception

If a retiring owner gives notice that he or she wishes his or her ownership interest to be

bought before the end of [insert number of months, such as “24”] months of ownership

of the company, he or she is entitled to receive only [insert percentage, such as “50”] %

of the Agreement Price for the sale of ownership interests in this company under this

agreement, unless he or she is required to leave because of serious personal illness or

injury or the serious illness or injury of a spouse, parent or child, in which case he or

she is entitled to 100% of the Agreement Price.

Option 2b: Disincentive period, without illness/injury exception

If a retiring owner gives notice that he or she wishes his or her ownership interest to be

bought before the end of [insert number of months, such as “24”] months of ownership

of the company, he or she is entitled to receive only [insert percentage, such as “50”] %

of the Agreement Price for the sale of ownership interests in this company under this

agreement.

Excerpt 3



Worksheet. If you want a retiring owner to

receive a discounted price if he leaves

within a certain time period for any reason, check

Option 2a on your worksheet. (Section III, Scenario 1, Option 2.) If you want a retiring owner to

receive a discounted price if he leaves within a

certain time period, unless he is leaving because of

a personal or family illness or injury, check Option 2b on your worksheet. If you check one of

these options, also:

• insert the amount of time an owner must be

with the company before being able to sell

out for the full Agreement Price, usually at

least one or two years, maybe more

• insert the amount of the discount to be

taken off the Agreement Price if an owner

leaves before the end of the required time

period.

Payment plans can help in these situations.



Allowing a flexible payment plan, such as

an installment plan, often allows continuing owners to pay a selling owner a higher price. You may



be wondering how Jed could afford to pay Dakon

100% of the Agreement Price after being in business less than a year. The best way to accomplish

a sudden buyout without bankrupting the business is to pay a departing owner in installments

over several years. When a death or disability is involved, planning to fund a buyout with insurance

is also an option. We cover insurance funding in

Chapter 5 and payment plans in Chapter 7.



b. Requiring Advance Notice of

Intent to Leave

Another smart way to ease the burden of a forced

buyout is to require an owner who wants to quit

or retire to give the company advance notice of

her intention to leave (except in the case of death

or sudden illness or disability, of course). In some

companies, requiring as much as a six- to twelvemonth advance notice is often considered reasonable. Our agreement requires a 60-day notice.

This should be adequate time for the remaining



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BUY-SELL AGREEMENT HANDBOOK



owners to take a collective deep breath and devise a plan to buy out the owner and continue

the business. Of course, if you and your business

partners think you’ll need more notice, you can

change the agreement to reflect this.

Worksheet. If you are interested in provid-



ing for a longer notice period, make a notation on your worksheet to change this time period. (Section III, Scenario 1, Option 2, Paragraph

(a).)



Be Ready to Customize Standard

Clauses to Fit Your Situation

Throughout this book we provide technical

language and options to solve common buy-sell

situations. But since every situation contains its

own nuances, you may want to tinker with our

clauses and clause options to be sure your

agreement fits like a custom-made glove, not a

one-size-fits-all handcuff. For instance, as noted

in the text, a well-drawn buy-sell agreement

will balance the desire to protect each owner in

case of personal problems with the need to

protect the financial integrity of the business.

We’ve talked about several ways to approach

this balance. But only you and your co-owners

know what’s best for your company.

If you want to provide a market for a departing owner without overburdening the company

and aren’t satisfied with the options we suggest,

such as requiring advance notice, a lower price

for leaving early and an installment payment

plan, you can create your own contractual

language. For example, a customized Right-toForce-a-Sale provision might state that the

departing owner must first try to find an outside

buyer who is acceptable to the other owners.

Assuming no buyer comes forward after six

months, your agreement could then provide

that the company or the continuing owners

must purchase the departing owner’s interest, at

a price discounted by 20% of the full Agreement Price. This discount gives the departing

owner some incentive to find an outside buyer

first, and lessens the immediate financial burden on the company and remaining owners.



PROVIDING THE RIGHT TO FORCE BUYOUTS



C. What If an Owner Becomes

Mentally or Physically Disabled?

The next business-disrupting event we consider

and help you plan for is the possibility that an

owner becomes disabled. Disability, of course,

includes physical injuries and illnesses, but also

can be caused by mental illness, such as clinical

depression, Alzheimer’s disease and other forms

of dementia or incapacity. Below, we discuss how

your agreement can deal with the tricky question

of whether an owner is truly disabled.

Disability and retirement buyout clauses

should be looked at together. If an owner



feels he cannot work and wants to be bought out,

but does not fit under a doctor’s or the disability

insurance company’s definition of disability,

arguments can arise. These conflicts can often be

defused in advance if you have also adopted a

clause allowing an owner to force a sale due to

retirement (discussed in Section B2, above).



1. Option of Company and Continuing

Owners to Purchase a Disabled

Owner’s Interest

What happens if an owner becomes injured,

develops a chronic illness or is otherwise unable

to participate in company affairs for an extended

period of time? If the owner is an investor and

was never involved in the day-to-day operations

of the business, the answer may appropriately be

“nothing”—after all, it probably makes little difference to the company whether an inactive investor

is or isn’t disabled.

But assume the owner has been active in the

business and takes a salary or regular draws from

it. For an owner who can no longer work but

takes money out of the company, there are obvious reasons why the other co-owners might

sooner or later want to replace her. Of course,

after a decent interval the co-owners could stop

the salary of the disabled owner (who, after all, is



3/13



no longer earning it), but allow him to continue

to own his share of the business. But the co-owners of a small company may not want to share

future successes and management decisions with

an owner who is no longer adding anything to

the company. In this situation, the co-owners

might want the right to buy out the disabled

owner.

Absent this right, there can be highly emotional

disagreements when a disabled owner does not

want to be bought out (he may even disagree as

to whether he is unable to perform his duties). It

is because of the debilitating nature of these

disputes that you need to have a disability-triggered buy-sell provision in place. Your agreement

can include a clause that allows the company and

the other owners to require a disabled owner (or

the owner’s conservator, guardian or other legal

representative) to sell her ownership interest back

to the company or to the other owners on demand. This protects the nondisabled owners of

the company from having to share management

with someone who can’t handle the requirements

of the job, or simply from having to support that

person.

EXAMPLE: George has been a partner of a



printing company for ten years, along with his

longtime friends Martha and Stew. Now in his

70s, he frequently experiences significant lapses

of memory. More than once his forgetfulness

has led to an unfinished job, and unhappy

clients have begun to whisper to Martha and

Stew that they no longer want to work with

George. George admits he is sometimes forgetful, but he insists that he is fit to continue

working. But when they almost lose their biggest client, Stew and Martha face the truth that

George is not mentally up to continuing to

work. Since George is a general partner

entitled to an annual share of the company

profits, the only sensible way to stop him from

receiving 1/3 of the company’s profits is to ask

him to sell out. But when confronted by Stew

and Martha, George refuses, threatening to get



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BUY-SELL AGREEMENT HANDBOOK



a lawyer. Martha and Stew rue the day, ten

years before, when they didn’t insist on a buysell agreement dealing with disability as a condition of starting the business.

Not for silent investors. If your company is



owned by both inactive, “silent” investors

and actively participating owners, this buyout

option may not suit your needs. (If an investor

was not working in the first place, disability should

not necessarily give him the right to force a

buyout of his interest.) Again, since most of our

advice is tailored to small businesses where the

owners are active in the business, we don’t deal

in detail with the special needs of investors. If

you face this situation, be sure to have an attorney

look over your agreement. We cover finding

expert help in Chapter 10.

Before you decide to adopt a disability provision, you’ll want to ask: Will the company or the

nondisabled owners be able to come up with the

money to buy a disabled owner out? After all,

most small to mid-sized businesses need every

penny they can scare up to maintain or expand

their business—they don’t have a ready store of

cash to fund a buyout. One way to cope with this

problem is to call for a long-term installment plan,

allowing the company or continuing owners to

make partial payments to a disabled owner over a

number of years.

But for larger companies, especially, there is a

better way to cope with this issue that doesn’t

make the disabled owner wait many years to be

paid off for her interest. Your buy-sell agreement

can require the purchase of disability insurance

for all co-owners. This way, if a disability occurs,

the insurance policy proceeds will provide a

source of funds to allow the company or the coowners to buy back the interest of a disabled

owner without diminishing company or personal

cash reserves.

If desired, additional financial benefits such as

a wage continuation plan for the disabled owner

can also be funded by disability policy proceeds.



(We discuss using insurance to fund your agreement in more detail in Chapter 5.)

Next, a big issue you’ll have to face is when an

owner is truly disabled. Our agreement specifies

that the owner must be “permanently and totally

disabled”—unable to perform most or all of his

duties. Our agreement also includes a procedure

to determine when an owner is considered disabled—using the opinion of the owner’s doctor.

Or, if your agreement will require disability insurance to fund the buyout of a disabled owner (discussed briefly below and in more depth in Chapter 5), the agreement provides that the insurance

company is the arbiter of whether the co-owner

really is disabled. (An added bonus of going that

route is that the other owners will be relieved of

the burden of supervising the disability claim and

asking the disabled owner for medical evidence

of a disability.)

There are several additional issues you should

consider to ensure that your disability clause has

the maximum chance of working well:

• Your agreement establishes a period of

time—a waiting period (or, in insurance

lingo, an elimination period)—over which

an owner’s disability must persist before a

buyout can occur. This allows for the fact

that the owner might recover. We recommend

that your waiting period be at least six

months, or perhaps as long as a year. A

buyout attempted before it’s really clear that

the owner probably won’t recover can result

in bitterness and wasted time and money,

especially if the former owner recovers. Our

agreement provides that time spent off work

by an owner with a series of illnesses with

the same or related causes can be added up

to fulfill the waiting period requirement.

Otherwise, requiring six months to a year of

continuous inability to work might discourage an injured or ill individual from returning to work if he’s feeling better (perhaps to

test whether going back to work would be

feasible). Of course, if your agreement will

require the purchase of disability insurance



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